Are the benefits of accepting bitcoin payments worth its risks?
It’s not just businesses that are curious about accepting bitcoin as a form of payment. The government is all ears, too. On Wednesday (April 2, 2014), the House Small Business Committee conducted its first-ever hearing on the cryptocurrency. The hearing examined the benefits and risks for small businesses of using bitcoin as a digital payment system.
The digital currency relies on peer-to-peer (P2P) technology. As such, it is completely decentralized, meaning no central bank or government regulates or backs bitcoin. Buyers transfer funds directly to sellers, without a third-party middleman to process payments between the parties’ financial institutions. Though primarily used in online stores, bitcoin is quickly gaining wide popularity amongst brick-and-mortar shops, food establishments, service-based businesses and even car dealerships. Big-name companies that currently accept bitcoin include Overstock and Virgin Galactic.
“Businesses choose to accept bitcoin for many reasons,” opened Chairman Sam Graves at the hearing. Those reasons include being at the forefront of technology, attracting customers who use bitcoin, lowering credit- and debit card transaction fees, and eliminating certain kinds of fraud, he said. [Accepting Bitcoins: What Small Businesses Need to Know]
Widespread bitcoin adoption can also potentially overhaul payment systems, said Congresswoman Nydia M. Velazquez. “Should currencies like bitcoin become widely utilized, they could create competitive pressure for conventional financial institutions to lower transaction fees in an effort to retain small business customers.”
Today, more than 13,000 online and brick-and-mortar small businesses accept bitcoin, an indication that the technology is gaining broader acceptance, Velasquez added.
Nonetheless, bitcoin is not without its risks. Price fluctuations, security concerns and the IRS’ recent ruling declaring bitcoin as a property — not a currency — leave many unanswered questions, Velasquez said.
The hearing attempted to address these issues, with testimony from Jerry Brito, senior research fellow at George Mason University; Adam White, director of business development and sales at bitcoin wallet provider Coinbase; and Mark Williams, executive-in-residence and master lecturer at the Boston University School of Management.
“Online, virtual currencies are nothing new,” Brito said, comparing bitcoin to existing payment systems like PayPal and Western Union. But the cryptocurrency does represent something new, he said. “Bitcoin is the world’s first completely decentralized digital currency, and it’s the decentralized part that makes it unique.”
Bitcoin eliminates the need for an intermediary, allowing users to complete transactions person-to-person, as they would with cash, Brito said. This makes bitcoin an attractive payment option for both small businesses and consumers, including those who don’t use banks, he added.
Benefits of accepting bitcoin
Bitcoin offers four primary benefits: lower transaction fees, merchant protection, increased sales and the ability to cater to consumer preferences.
First, the lack of a central intermediary dramatically reduces transaction fees. Small businesses accepting credit card payments often face fees of around 25 cents for each card swipe, plus 2 to 4 percent of the transaction total,” Brito said. These costs add up, which explains the credit card minimums at businesses like dry cleaners and convenience stores, he explained. “In contrast, businesses that use a merchant processor like BitPay or Coinbase pay fees of 1 percent or less on bitcoin transactions. If you are a small-margin business, that difference could mean doubling your profits.”
Bitcoin’s decentralized setup also protects merchants from fraudulent chargebacks. The transactions, like cash, are final, because no third party can reverse charges, Brito said. “This protects small businesses from chargeback fraud, which often results not just in the loss of the sale, but also in penalty fees,” he said. “If a merchant has 1 percent of their charges reversed as chargebacks, they can be kicked out of the credit card networks, potentially ending their business.”
Moreover, as a decentralized payment system, bitcoin enables small businesses to expand and open their doors to international buyers for whom their products and services were once inaccessible. “There are over 50 countries that traditional payment processors do not serve, often because of high fraud rates,” Brito said. “Because bitcoin payments are global and final, doing business with consumers in those countries is now feasible.”
For example, a small electronics retailer reported selling $300,000 worth of merchandise to nearly 40 countries by accepting bitcoin, Brito said. Those countries included Pakistan and Moldova, which, before bitcoin, were unavailable to American merchants.
“Bitcoin democratizes foreign exchange and enables frictionless, cross-border transactions that settle immediately,” White said. This means that during transactions, a bitcoin payment made by customer in New York looks just like a bitcoin payment made by a customer in London, Buenos Aires or Tokyo, he said. “The ability to easily begin accepting payments from customers around the world can open up whole new markets for merchants, and significantly improve top-line revenue.”
Accepting Bitcoin offers another advantage by giving customers an additional way to pay, while providing an extra layer of protection to keep their information safe.
“Bitcoin enables individuals to push payments to merchants without having to share personally identifiable information,” White said. Customers thus avoid the risk of cybercriminals intercepting transactions and capturing the person’s information for fraudulent purposes, he said. “This push functionality gives bitcoin a unique characteristic that eliminates the risk of fraud, something that merchants, card processors and banks spend billions of dollars per year combatting.”
For instance, Target’s massive data breach in 2013 — which compromised more than 70 million consumers’ credit card information — would not have been possible with bitcoin, he said.
“We see bitcoin as an extremely powerful technology, and it is our goal to bring the efficiencies created by the bitcoin network to the masses,” White said.
Risks of accepting bitcoin
Despite its benefits, there are several drawbacks to accepting Bitcoin as a form of payment. The most pressing concerns are volatility and security.
The highest risk to Bitcoin is its price volatility, which makes the cryptocurrency’s value extremely unpredictable. To illustrate, bitcoin was first valued in pennies when introduced in 2009, but rose to $1,200 in December of 2013 with “wild short-term swings,” Brito said. After hitting that peak, bitcoin’s value plummeted to $600.
“One month or even one week in the bitcoin world can be equivalent to a decade in other markets,” Williams said. Although bitcoin’s value has risen significantly, the pattern is far from a continuous upward trajectory. “Despite the dramatic rise in 2013, prices have not been a one-way space rocket to the moon,” he said. “Since November 2013, Bitcoin has slid by over 60 percent, to $462.”
Williams also referred to Coinbase’s own disclosure statement as a testament to bitcoin’s volatility risk. “As part of the new-account setup process, Coinbase describes bitcoin as a virtual currency that could drop to the price of zero,” he said.
Brito argued, however, that Bitcoin itself is not naturally volatile. “Its volatility is likely attributable to the fact that it is a new currency, still in the process of discovering its stable price,” he explained. “As a nascent currency, it is very thinly traded, and as a result a single, large-enough trade can affect the exchange price substantially.” These price fluctuations should stabilize as Bitcoin adoption grows and when derivatives become available for investors to bet against the currency’s price, he added.
Even so, small businesses don’t actually have to worry about volatility while accepting bitcoin if they use a merchant service company, such as BitPay or Coinbase, Brito said. That’s because, under these services, bitcoin payments are done in real-time for the currency’s current value.
“Merchants can denominate prices in dollars, accept bitcoins for payment at the current exchange rate and then immediately convert those bitcoins to dollars,” Brito explained. “A business that accepts bitcoin payments never has to hold bitcoins.”
Although bitcoin transactions eliminate cyberthreats like stolen credit card numbers, the currency still isn’t 100-percent safe. So far, there is no way to completely prevent cybercriminals from getting their hands on users’ bitcoin wallets.
Case in point, 2014 has been a rocky year in bitcoin security. Williams highlighted the following events that have cast doubt on the currency’s safety:
- On Jan. 9, 2014, Alibaba, the Chinese equivalent of Amazon, stopped accepting bitcoin. Two weeks later, Charlie Shrem, co-founder and CEO of bitcoin exchange startup BitInstant and founding member of the bitcoin Foundation, was arrested for allegedly laundering $1 million worth of bitcoins.
- In February, Mt. Gox of Japan, formerly the world’s largest bitcoin exchange platform, which accounted for 80 percent of trading volume, announced it had been hacked. Later, the company disclosed customer losses of more than $400 million. The attack also affected major exchanges Bitstamp (Slovenia) and BTCe (Bulgaria). Earlier in the month, Russia declared Bitcoin an illegal tender, affirming the Ruble as the sole official currency.
- On March 11, 2014, the U.S. Financial Industry Regulatory Authority released a stern warning to investors about the dangers of buying and using virtual currencies. And on March 24, 2014, the Internal Revenue Service dealt a further blow to bitcoin, ruling that it is not a foreign currency, but should be taxed as property. (This means that Bitcoin gains must be reported on tax returns.)
Given these circumstances, bitcoin as a virtual currency poses significant risks to small business owners, Williams said. “These risks need to be carefully evaluated before deciding whether or not to venture into these new, uncharted waters,” he said.